European Heads of State Sign the „Treaty on Stability, Co-ordination and Governance in the Economic and Monetary Union“
The bureaucratese mouthful above that describes the new 'fiscal compact' seems to indicate that 'growth and stability' are no longer enough. It may or may not be significant that the word 'growth' didn't rate a mention in the naming of the treaty. For those interested in the official pablum release, here it is (pdf).
The EU Observer tells us:
„Germany's vision of an EU of fiscally prudent states held in check by tight budgetary laws and the threat of legal action came a step closer on Friday (2 March) when 25 leaders signed a new treaty on fiscal discipline.
In a low-key signing ceremony, all countries except the UK and the Czech Republic, became signatories to the 16-article pact, which, after going under a variety of monikers, has now been lumbered with the title "Treaty on stability, co-ordination and governance in the economic and monetary union."
"Its effects will be deep and long-lasting." said EU council president Herman Van Rompuy ahead of the signing, adding that it will help prevent a "repetition of the debt crisis."
It will 'prevent a repetition of the debt crisis'? What, the debt crisis is over? We evidently didn't get the memo on that yet. In fact, while the ECB's LTRO machinations have undoubtedly bought time by inviting new carry trades, they have also immensely increased the risks to the system. When, not if, the crisis returns, it may be all the worse as a result.
Consider that in order to access to all that 'free money', banks had to encumber a great many assets at varying haircuts. Then they turned around and added more assets to their smoldering pile by going 'all in' on their sovereigns' debt, an effect especially pronounced in Spain and Italy. It is therefore now a sine qua non for these nations to 'follow through' on their various austerity plans and hope they don't screw it up and end in a vicious spiral. As we have chronicled in these pages, there have been a number of 'supply side' type reforms enacted in the crisis stricken nations that may, given enough time, bear fruit. The problem from our point of view is that these reforms don't go far enough by a long shot. The EU hasn't suddenly become an unhampered market economy overnight. As a reminder, consider the horror story about trying to open an online business in Greece.
However, money supply growth is of course a decisive factor in determining when the next phase of the crisis begins. A strong dose of money supply growth can as a rule help to mask the underlying problems, as it will always serve to distort prices, thereby creating a kind of financial Potemkin village: people see the newly polished facade, but they don't see the crumbling structure it hides. Ambrose Evans-Pritchard recently reminded us that in the euro area, money supply growth rates remain very uneven. Money flows to those nations that are already brimming over with way too much of the stuff, while it continues to flee from the periphery. For the latter, this has the considerable advantage that capital malinvestment has been stopped dead in its tracks and that the liquidation of unsound investments proceeds apace. Alas, given the large public and private debt loads extant, this process is anything but painless. Moreover, the eurocracy is busy propping up unsound credit and imbalances instead of allowing the markets to adjust freely.
Deposit money growth in the euro area, core versus periphery.
Deposit money growth in the PIIGS, disaggregated. Not surprisingly, Greece is leading the pack.
The new fiscal treaty on the surface appears to give the eurocracy in Brussels immense power to intervene and stop fiscal profligates in their tracks. Alas, as the EU Observer notes, numerous pitfalls attend the agreement:
“In line with Berlin's wishes, the text includes an article obliging those that ratify it to enshrine a balanced budget into national law, while a country breaching the budget deficit rules will be subject to intense surveillance, with curbed discretionary spending powers, and obliged to carry out an agreed list of structural reforms.
Ahead of the signing, German Chancellor Angela Merkel said the treaty represented a "strong signal" on how the EU is dealing with the eurozone crisis and spoke of a "politically unified Europe" of the future.
The treaty was drawn up in a record two months but it is an only intergovernmental agreement, after the UK in December vetoed a full-blown EU treaty change.
The awkward status – outside the EU's normal architecture – has had lawyers scratching their heads over how to get EU institutions to implement it. It has also weakened the treaty's bite as countries breaching the implementation of the balanced budget rules can only be brought to court by another member state – a politically difficult option.
The treaty will go into force once 12 of the 17 euro countries have ratified it, and only those that have done so will have access to the eurozone's permanent bail-out fund, the ESM – a provision pushed by Berlin. The agreement foresees that eurozone country leaders will hold summits twice a year, an arrangement that some non-euro countries fear will fortify divisions between the 'ins' and 'outs.'
Designed to ease German political and public opposition to further bail-outs, critics say the treaty, with its belt-tightening focus, risks worsening Europe's struggling economy. The biggest debate on the treaty is likely to be in Ireland where it will be put to a referendum – the debate has already started about what concessions Ireland should seek to sweeten the vote for a population looking to vent its anger at having to foot the bill for bad behaviour by banks.
Another wrinkle in German Chancellor Angela Merkel's plan is the possible election of Francois Hollande as French President later this spring. Hollande – while backpedalling on previous, much stronger comments – has said he wants the treaty to have more emphasis on growth and questioned the exact role of the European court.”
If other nations were to follow Ireland's example and hold a referendum over the 'fiscal compact', the euro area would probably break apart, as the agreement would likely be rejected by increasingly agitated and restless voters. As it were, the growing probability that the old-line socialist extremist Hollande will win France's presidential election casts immense doubt on the whole exercise (more on Hollande further below).
So we have to consider two aspects here: firstly, the fact that the economic imbalances within the euro area remain unaddressed and that there seems very little time to address them convincingly before markets go haywire again. Secondly, the political pressures continue to mount along with the economic downturn, making it ever more likely that the euro project will founder on political grounds.
The Rift Within the ECB Grows Again
Anyone thinking that Jens Weidmann – chief of Germany's Bundesbank and hence presiding over the biggest 'TARGET2' claims in the euro area and the by far biggest surge in central bank balance sheets in the region – would remain quiet while the ECB doled out a trillion euros in its LTRO operations, has just been disabused of the notion.
As Reuters reports:
“Some European Central Bank policymakers are alarmed that a dramatic loosening of lending policy stemming from a 1-trillion-euro wave of cash unleashed into the financial system will fuel imbalances in the euro zone and stoke inflationary pressures.
Led by Bundesbank chief Jens Weidmann, who was previously a top advisor to German Chancellor Angela Merkel, they are pushing for the central bank to think about an exit strategy after it fed banks 530 billion euros on Wednesday in the second of two cheap, ultra-long funding operations.
The signs of internal division add weight to what sources have already told Reuters: that the central bank does not intend to offer any more cheap three-year cash. The chances of interest rates dropping below their record low one percent also appear to be diminishing. The huge take-up at Wednesday's so-called LTRO meant that in the space of two months the ECB has injected over a trillion euros into the financial system.
While the twin operations have banished the threat of a credit crunch, the ECB hawks are worried that the ploy risks fostering banks forever dependent on external support, fuelling imbalances between strong and weak euro zone members and priming an inflationary timebomb for the future.
Weidmann wrote to ECB President Mario Draghi last month to express concerns about risks stemming from a decision the ECB took in December to ease rules on the collateral banks must put up to tap its funding operations, a central bank source said.
That decision, which Weidmann opposed and now wants reversed, resulted in some 800 banks partaking in the ECB's second offer of one percent money on Wednesday – a marked increase from the 523 bidders at the first LTRO in December.
"This shows that there are diverging views on all of this in the ECB Governing Council and it is not likely go away until the sovereigns come up with some big measures, which looks rather unlikely," said Citigroup economist Juergen Michels.
Draghi asked Weidmann to put his views on paper after they discussed the issue of growing imbalances in the euro zone's cross-border payment system TARGET2, which have essentially seen central banks in weaker economies build up liabilities which could fall on the stronger ones.
The Bundesbank chief believes those risks could be exacerbated by the looser collateral rules, the source said. The issue is also being debated more widely in the ECB's 23-man Governing Council.”
It is important to realize here that the risks Weidmann talks about will most likely be realized in the event of the euro area's break-up. This is especially true of the 'TARGET2' imbalances that are used to surreptitiously finance the current account deficits of the PIIGS. The Bundesbank now wants to push for collateralization of TARGET2 claims, something that is not likely to happen. Moreover, it appears that the differences of opinion within the ECB's governing council are not only focused on the recent change in collateral rules – they include virtually every policy step that has been taken under Mario Draghi's leadership. As Reuters continues:
“Draghi can ill afford to ignore the ECB hawks' concerns. Last year, two German heavyweights on the Governing Council quit in protest at the ECB's controversial program to buy sovereign bonds – a measure they felt came too close to financing governments. Weidmann too opposes this option.
Some within the ECB have also lost on some key policy decisions last December – a cut in interest rates to a record low of 1 percent, and the loosening of the collateral rules. The Bundesbank also pushed for a higher interest rate on the 3-year LTROs, but failed to convince other Council members.
Draghi only assumed the ECB presidency after Weidmann's predecessor, Axel Weber, quit early last year, clearing the way for the Italian to take the helm of the euro zone's most powerful institution despite the concerns of many in Germany. The Italian risks a deep and damaging split on the Council if he tests the hawks too far, weakening the ECB just a few months into his eight-year presidency.
But it may be that after such a dramatic start in policy terms he too is content to take a back seat now. Certainly, in public Draghi has consistently put the onus on euro zone governments to take the lead. The ECB looks set to leave interest rates on hold at 1.0 percent far into 2013, according to the consensus of more than 70 economists polled by Reuters, who until three weeks ago forecast a rate cut later this year.
Draghi is already at odds with some powerful voices in Germany, taking a nonchalant view last month about the TARGET2 imbalances. The Bundesbank considers the TARGET2 imbalances a symptom of underlying problems in the currency bloc and is watching them with increasing concern as they reflect a stronger reliance of banks in weaker euro zone countries on cheap ECB funding and growing risks on those countries' central banks balance sheets.
If the euro zone breaks up – which few expect – the larger national central banks in the 17-country bloc would be left with a greater share of the potential losses, as they contribute a greater share of the ECB capital.
Hans-Werner Sinn, president of Germany's influential Ifo think-tank, has argued that stronger countries such are financing the deficit extravaganzas of Greece, Portugal and Ireland via the euro zone cross-border payment system. Draghi played down these concerns last month, telling the ECB's monthly news conference: "We, the Governing Council, thought that the amount of risk that was taken on board was perfectly acceptable and very well managed."
The Bundesbank wants to assess the idea of peripheral euro zone central banks providing collateral to those in the bloc's core as a back-up for the TARGET2 imbalances – an idea they are unlikely to buy.”
This once again goes to show that the same political differences that make the decision-making processes in Brussels so cumbersome and ineffective run right through the central bank as well. The Bundesbank wants the ECB to be a perfect copy of itself in terms of its philosophy and policy – but that is simply not possible.
“Weidmann had already expressed concern that "too generous" supply of liquidity could create risky incentives for banks, which could in turn store up future inflation risks. Ewald Nowotny, a member of the ECB's 23-man Governing Council, went further on Tuesday and said the bank should think about an exit strategy after its massive cash injections.
Their case may be supported by a pick-up in euro zone inflation in February to 2.7 percent from 2.6 in January, well above the ECB's target of just below 2 percent.
The ECB hawks' bargaining position could be further bolstered if Luxembourg's central bank chief, Yves Mersch, takes over from Spain's Jose Manuel Gonzalez-Paramo on the ECB Executive Board from June 1.
Mersch, who has one of the strictest anti-inflation stances among ECB policymakers, is seen as the frontrunner for the post, which manages the ECB's day-to-day business.”
The way we see it, this means that our previously uttered prediction – namely that the ECB will go into 'wait and see' mode following the LTRO injections, which will lead to a slowdown in money supply growth after the initial push higher has fully unfolded – will likely prove correct.
As we noted here:
“So we can probably expect the current batch of measures to go through the same process: after an initial spike in money supply growth that at present supports bond and stock markets alike, growth in monetary aggregates will once again slow down until it has slowed down enough to unmask the fact that the crisis has never ended.”
This will eventually allow us to make a few educated guesses as to when the next phase of the crisis begins. For now, we are still awaiting the money supply data for the first quarter in order to be able to gauge the effect the LTROs have had on money supply growth rates in the short term. Longer term, it is already all but certain that this expected growth in money supply will taper off again and precipitate the next, and perhaps final, iteration of the crisis.
The 'Firewall' Song and Dance
It appears that another recent off-hand assessment of ours is about to come to pass. In 'G20 Aid for Europe Deferred' we wrote in the context of whether the 'firepower' accorded to the ESM would be increased against ostensible German resistance:
“As far as we are concerned, such German declarations that the 'buck (or rather the euro) stops here' are as credible as anything that comes out of the eurocracy, which is to say, they rate precisely zero on the credibility scale. In the main these announcements are designed for the German domestic political audience, but they are certainly not to be taken seriously.”
Today we learn that German resistance to increasing the funding of the EFSF/ESM combo is already crumbling at warp speed:
“The German government will decide whether to boost the European bailout fund in March and its parliament is very likely to support any decision for more resources, Finance Minister Wolfgang Schaeuble said on Saturday.
G20 officials in Mexico City have urged Germany to back a plan for Europe to increase its rescue fund, which could pave the way for other G20 nations to contribute extra money to the resources on hand at the International Monetary Fund.
Schaeuble noted that Germany's decision would come before top finance officials meet again at the IMF in April. "And it's going to be in time for the IMF to be able to make a corresponding decision at the spring meeting in Washington on the firewall," he said.
Germany, Europe's chief paymaster, is keen to avoid raising extra crisis funding needlessly, and Schaeuble noted in a speech earlier on Saturday that financing conditions for euro zone nations have improved in recent weeks. But advocates of a bigger firewall say more resources are needed to send out a clear signal to markets that the bloc will do whatever is necessary to defend the euro currency.
The plan is to merge Europe's temporary and permanent bailout funds, the European Financial Stability Fund and the European Stability Mechanism, to create one 750 billion euro ($1 trillion) fund. Once Europe has enlarged its bailout fund, other countries have said they will bolster the IMF's resources.
Schaeuble was speaking not long before the German parliament was due to vote on Monday on whether to endorse a new 130 billion euro ($175 billion) bailout package for Greece, which has been at the heart of the euro zone crisis. The minister said he expected the Bundestag to give its approval to the second Greek package.
This was foreshadowed by recent comments by Mario Monti, the current unelected 'technocrat' heading Italy's government and also by comments made by Luxembourg's prime minister J.C. Juncker, the current head of the eurogroup.
“Italian Prime Minister Mario Monti, signaling the worst may be over for the euro region’s most distressed bonds, said he expects leaders to strike a deal by the end of the month on expanding a debt-crisis firewall.
While German Chancellor Angela Merkel has expressed reluctance to discuss increasing the size of Europe’s bailout kitty at a European Union summit in Brussels beginning today, Monti said he’s “confident” a deal will come.”
Luxembourg Prime Ministerv Jean-Claude Juncker, who is chairing today’s euro finance ministers gathering, urged governments to expand the crisis firewall as soon as possible or risk losing momentum in the markets.
“It would not be the first time we would be a little bit too late,” he told reporters after an appearance at a European Parliament committee meeting yesterday.
We would interpret this as part of the 'quid pro quo' haggling that is probably going on behind the scenes: Germany got its desired 'fiscal compact', but now it must agree to all sorts of things it is not very eager to agree on. The additional risk it takes by enlarging the ESM's funding is also going to become fully manifest once the euro project fails.
Economic Contraction Continues
While the contraction in euro area-wide slowed down further in February by edging up to 49 (still contracting, but at a slower pace than previously), there were once again wide differences between 'core' and 'periphery' data.
“National data showed manufacturing activity expanded modestly in Austria, the Netherlands and Germany. France's PMI rose to a seven-month high at the no-change mark of 50.0, while Ireland and Italy remained in contraction territory but saw PMIs rise. Spain's PMI fell to a two-month low at 45.0, while Greece posted a record-low reading of 37.7 for the manufacturing sector.”
The utter collapse of (pdf) is quite a sight.
The long term history of Greece's PMI. It has now plunged to a new low, with the decline accelerating markedly.
As Markit's Chris Williamson comments on the Greek data:
“The Greek manufacturing sector fell deeper into recession during February as both output and new orders declined at series-record rates. Purchasing activity was also lowered at the fastest pace in the survey history amid reports of ongoing difficulties accessing working capital and demands from vendors for cash payments. There were reports that working hours were being cut, while job losses were again heavy as workloads continued to diminish.
The headline Purchasing Managers’ Index® (PMI®) – a composite indicator designed to provide a single-figure snapshot of the performance of the manufacturing economy – fell to a survey low of 37.7 in February (data have been collected since May 1999). Moreover, the PMI has now posted sub-50.0 readings in each of the past 30 months, with the rate of deterioration accelerating since the turn of 2012.
Underlying the steep deterioration in operating conditions in February were the most severe reductions in output and new orders recorded in nearly 13 years of data collection. Respondents commented on shortages of working capital at their plants and amongst clients, while austerity measures continued to undermine demand. Sales of Greek manufactured goods were down from both domestic and foreign sources: new export orders fell for a sixth successive month and at the steepest pace since May 2010.
A number of survey respondents noted that reduced working hours had also led to lower output volumes in February. This was in the main deliberate as a number of manufacturers tried to avoid job losses by cutting days worked for employees. Nonetheless, employment losses were inevitable and the degree to which payrolls were reduced was the steepest since March 2009. Employment has continuously declined throughout much of the past four years.”
This has of course also had a noticeable effect on the tax revenues of Greece's government, putting the government's fiscal goals further out of reach:
“Greece's deep and prolonged recession took its toll on the central government's finances, which swung from surplus to deficit, official figures showed Friday.
Provisional figures from the finance ministry figures showed Greece posting a deficit in January of €490 million ($652 million), in contrast to last year's equivalent surplus of €154 million.
The ministry's General Accounting Office said revenues during the month were hit by the expiry of a one-off business tax, as well as reduced revenues from consumption.
Revenues in January totaled €4.87 billion ($6.48 billion). Though a little bit better than the government's latest target, it's markedly worse than last year's equivalent of €5.12 billion.
When Mr. Schäuble says that the second bailout of Greece is unlikely to be the last, we'd be inclined to believe him – with the obvious reservation that the euro area, or at least Greece's membership in it, may not last that long.
In spite of the slight increase in output in several of the 'core' nations, unemployment in the euro area as a whole has increased to a new high since the adoption of the euro. At 10.7%, the euro-area-wide rate of unemployment is beginning to reach extremely worrisome proportions.
Our impression is that the markets have become way too nonchalant about all these developments in the wake of the LTRO injections. Let us not forget, in the end all these actions are a symptom of growing desperation: they are not a sign that things are getting better, but that they have become so bad that extraordinary interventions are held to be 'necessary'. Eventually the markets will sober up again and then they will have to discount the ongoing deterioration in economic conditions.
Addendum: France's Francois Hollande
As German news magazine 'Der Spiegel' recently reported, Mr. Hollande currently leads Nicolas Sarkozy by 58 to 42 in the polls.
It is interesting what Mr. Hollande's political philosophy apparently entails. As one might expect, he has well-honed class warrior skills. In particular, he thinks that it is the State's job to determine what represents 'excessive income'. Apparently oblivious to the fact that he is about to destroy all incentives for the remaining creators of wealth in France to continue with their efforts, he aims to introduce what can only be called truly punitive tax rates.
We know of course that European governments are in essence highway robbers, and this is of course especially pronounced among socialists. Tax rates are so high, the State has become such a huge portion of the economy, that it is a miracle the crisis has not arrived much sooner. We wonder whether the French voters know what they are getting in for.
Der Spiegel writes:
“If the Socialist Party's candidate wins the current presidential election in France, the country's highest earners may be faced with massive new taxes. Francois Hollande says he wants to introduce a wealth tax of 75 percent on income of over 1 million euros per year.
Francois Hollande, the Socialist Party frontrunner for the French presidency, announced a tax plan Monday that would see taxes on the wealthy rise dramatically if he is elected this spring.
Speaking on TF1 television, Hollande proposed a 75 percent tax on income over €1 million ($1.34 million), a huge jump from the current top rate of 40 percent.
"I can announce here that above €1 million (per year), the tax rate should be 75 percent, because it's not possible to have that level of income," said Hollande, who added that he did not accept "excessive wealth."
Hollande has consistently held a commanding lead over incumbent President Nicolas Sarkozy among French voters, who will take to the polls for a first round of voting on April 22 and a runoff on May 6.”
Alas, once the State begins to confiscate what it deems to be 'excessive wealth', all that happens is that wealth simply disappears, never to be seen again. One only has to imagine the situation from the point of view of an entrepreneur – who, not to forget, bears the fulls risk of every decision he makes – earning money above Mr. Hollande's arbitrary 'excessive wealth' threshold. Why would he continue with his efforts to create wealth above this threshold? Obviously it would be far better to just 'go Galt' and retire on the Seychelles or some other tropical paradise. Why would anyone work and take risks to fill the coffers of a rapacious government? If France elects Mr. Hollande and he goes through with his plans, you can prepare for the country to become the next Greece in a real hurry. As Mrs. Thatcher once wisely remarked: “Socialist governments traditionally do make a financial mess. They always run out of other people's money. It's quite a characteristic of them."
Mr. Hollande may well end up surprised how quickly wealth can disappear in a globalized world when a government introduces confiscatory tax rates like the ones he mulls. He seems to have forgotten that the poor can not give his fellow Frenchmen any jobs. It is the hated entrepreneurs that are the only source of jobs and wealth in the country. Cast them out, and you will soon go back to third world living standards.
The anticipatory grin of a rapacious highway robber: Francois Hollande.
(Image source unknown)
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